Steno Signals #44 - Are you sure that you prefer another currency to the USD?
The de-dollarization chatter is back after the IMF COFER data showed a new drop in the size of USD FX reserves in Q4-2022. Currently, everyone agrees that the USD will weaken from here.
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Is the USD going to weaken further from here? That is currently the overwhelming conclusion made by many, but our models are starting to turn. Here is why the USD bear case could be weakening (a short extract from our Weekly editorial at www.stenoresearch.com)
The US disinflation narrative is 100% consensus, the long EUR vs USD is 100% consensus and the “ECB will hike longer than the Fed” is 100% consensus. An overwhelming majority even find European banks to be in a better spot than US peers. Fair enough. It is admittedly hard to build a strong case for the USD right now, but that is in itself interesting.
We like to use probability weighted price models to ensure that we don’t end up pushing a consensus narrative that you could just as well have read in Financial Times every week.
If ECB to Fed expectations are WIDE (EUR – USD assets), the statistical conclusion is that the market is more likely than not to be disappointed with such an allocation. Our broad DXY model is now printing at around 50%, meaning that the USD development from here is a cointoss in statistical terms, which seems like much better odds than most active players currently assess to it.
Chart 6: Probability of stronger USD is now INCREASING again
The USD has suffered from 1) the weakening expectations for the Fed and US inflation, 2) large net additions to USD liquidity from the Fed / US Treasury relative to the ECB and 3) overall secular (but very strong) trend towards a larger diversification of FX reserves, but reserve managers are NOT buying CNY with the USD proceeds.
The relative liquidity picture is another reason why the USD tide could be turning as the relative injection power of the US Treasury / European dittos is now heavily turning in favor of the European having the most possible liquidity to add.
Find the full story here → https://stenoresearch.com/steno-signals-44-are-you-sure-that-you-prefer-another-currency-to-the-usd/
Chart 7: As the TGA is already below $100bn, the net liquidity additions are likely to pause
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question: what period does the probability figure in the model attempt to predict? is this a 50% probability that DXY is higher in a quarter? or 1 month?
Thanks